Profitability

Margins are solid, but profitability pressures remain

As consumer tastes evolve and market demands get more diverse, food and beverage companies have had to spend more money reformulating existing products and creating new ones, while also cutting expenses to ease pressure on profit margins. Global players faced the greatest struggle in this area, as 13 of the top 25 food and beverage firms experienced revenue declines in 2016, with a third of those companies also seeing lower profits.15

While small and middle market companies are more adept at navigating shifting consumer trends than larger competitors, they are also tightly focused on expense management. In fact, 43 percent of all executives in the Monitor survey plan to increase profitability in the next year by making operational cost improvements. Interestingly, 42 percent of U.S. food and beverage companies also want to deploy new financial strategies to boost profitability, well above the one-third of non-U.S. leaders considering that approach.

Operating profits look strong

If operating margin is the truest measure of profitability, middle market companies are delivering a solid performance when compared with national benchmarks. According to CSI Market data, public food processing companies in the United States produced operating profit margins (before interest and taxes) of 7.6 percent in first quarter 2017.16 That figure is in the 6 to 10 percent “sweet spot” in the Monitor survey, since the greatest number of leaders report their companies produced operating profits in that range over the past fiscal year.

Over the past fiscal year, about 22 percent of leaders reported a double-digit rise in operating profits for their companies. Looking ahead, those executives are slightly more optimistic, with 26 percent forecasting a similar bump in profitability during the next 12 months.

Mixed signals on workforce issues, profitability pressures

While steady growth in most developed and emerging economies has benefited sales of food and beverage products, it has also created certain side effects that affect profitability. For instance, a recent global industry study found that half of food and beverage makers are having trouble recruiting skilled workers, and 27 percent say unskilled workers are also hard to attract. The workforce issues were more significant in emerging market portions of Asia, followed by developed nations in Europe and Latin America.17 Interestingly, middle market leaders in the Monitor survey disagreed with that viewpoint, as just three in 10 U.S. or non-U.S. companies say skilled labor availability will be a hindrance to growth during the next year.

On the other hand, executives express a much higher degree of concern when skilled labor is viewed through the lens of profitability. In fact, 47 percent of all Monitor respondents say tight competition for talented workers will have a negative effect on near-term profitability, with 71 percent saying that employee wage and benefit costs will increase in the next 12 months. Taken as a whole, these findings most likely reflect increased competitive pressure on local market wages to keep good talent in place, along with other recruiting or retention incentives, such as signing bonuses, referral bonuses or cash counteroffers.

Unlike workforce cost pressures, which were felt equally in U.S. and global markets, the survey did reveal some clear differences by geographic location. For example, 47 percent of non-U.S. executives see commodity price fluctuations as a threat to profitability, significantly higher than the 34 percent of U.S. business leaders who share that view. Non-U.S. companies are also more concerned about margin pressure from food service distributor requirements (41 percent versus 31 percent of U.S. firms), funding access (37 percent versus 27 percent), and the cost of more aggressive trade and promotion spending (36 percent versus 26 percent).

Tame inflation levels across most developed economies have conditioned consumers to expect slow or no price increases at retail levels, which helps explain why four in 10 Monitor survey respondents say a pricing power shift toward customers represents a modest or significant barrier to growth. To cover increasing costs and maintain profit margins, executives say their companies are optimizing logistics operations (47 percent) and inventory management systems (41 percent).

While 77 percent of respondents say their companies did raise prices over the past 12 months, most of that extra revenue was most likely covered by suppliers, wholesalers and other links in the supply and distribution system. In turn, three-quarters of food and beverage companies say their expenses for raw materials, components and other goods rose in the last year.

What this means

Food and beverage companies operate on some of the thinnest margins of any business sector. That’s why it’s vital to take a broad view of forces that can help improve overall profitability.

Take a closer look at the growth drivers. Sometimes, the process of subtraction can deliver surprising additions to operating profit margins. By using a well-constructed margin analysis, food and beverage companies can uncover the evidence necessary to discontinue underperforming product lines, exit unprofitable markets or revise contracts with low-margin customers. This analysis enables leaders to apply limited resources toward higher-margin areas.

Look beyond margin metrics. While gross margin and operating margin are direct barometers of how much money a company is making, there are several secondary factors that should be regularly considered when analyzing overall profitability. For instance, a subpar customer retention rate will generate higher costs of acquiring new business, which puts pressure on profits. Similarly, metrics showing higher-than-average employee turnover, poor inventory management and non-optimized supply chain agreements all represent solid opportunities to improve profitability.

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